One of our readers asked some good practical issues about insurances inside your SMSF which I think you’ll find interesting. Here is their question

I have a SMSF and my husband and I are beneficiaries. We are both 56 years old. We currently have group life cover in the fund but not TPD. We were wondering:

1. If, God forbid, one of us becomes disabled or gets sick (such as cancer), before age 60, could our SMSF pay out the members fund balance? What, if anything would be the tax consequences of this be? Obviously the fund would need to sell the shares if the money could be accessed, but would they still be subject to capital gains tax if the money were being paid out for this purpose?
2. If one of us were to pass away (again God forbid), it is my understanding that the life policy would be paid out to the surviving spouse tax free. However, could the fund balance in shares of the deceased beneficiary be just moved over to the surviving beneficiary so that the shares don’t have to be sold?

Illness and injury

Let’s deal with Part 1 first. At a super law level you’re asking about two different types of disability – temporary and permanent.

Under the super laws temporary disability arises when you can’t work due to illness or injury, which isn’t permanent. Definitions in your trust deed might be more restrictive so make sure you check it too.

Your question relates to the possibility of getting sick. The early diagnosis of most illnesses doesn’t immediately involve discussions about permanent stopping work or imminent death. In fact, most people who become ill stop work for up to 36 months so they can receive intensive medical treatment and recuperate. Once cured they often return to work full-time.

For reasons that I explain in this article you can’t take any of your savings out of your super fund were you to suffer from temporary incapacity.

So if you want to receive any money from your super fund because of a temporary incapacity, your fund will have to own what’s called salary continuance insurance or income protection insurance. You should also read this article as it contains important information about the type of policy your fund’s trustee can buy.

Now what about permanent incapacity? Well under these rules, you have to be suffering from mental or physical ill heath that, in your trustee’s view, will prevent you from ever working again in a job that involves your levels of education, training and experience that you would have at the time you’re disabled. Again this is the super law definition.

Your trust deed may be more restrictive this than this – for example, it might say that permanent incapacity benefits are only available if you are unlikely to perform any work in the future.

If your trustee decides you satisfy this definition, then all the money you have in your super fund can be paid out to you. If two medical practitioners make a similar declaration, then specific and often substantial tax concessions will be attached to your permanent disability benefit.

These permanent incapacity benefits can be paid as a lump sum or pension.

How it is paid will depend on your trust deed, what you want and what your trustee is prepared to do. Many older SMSF deeds only allow these benefits to be paid as a lump sum.

If a pension is permitted, then when the pension commences, the tax rate on the assets paying the pension falls from 15% to 0%. If a pension is being paid, any assets sold that fully support that pension will typically not be subject to capital gains tax.

If a lump sum is paid then the assets will be sold when your fund’s tax rate is 15% which means CGT, if relevant, will be payable.

Death

Now to deal with the second question. Yes the death insurance policy claim proceeds will be paid into the super fund as capital and are not taxed. When these proceeds are paid out to a dependant beneficiary, then lump sums are typically paid out tax-free.

As an aside, please note that only two death benefit lump sums are permitted.

Pension benefits come with tax concessions – please see the table below – dependent on the age of the deceased and the beneficiary who receives it. Any assets sold when paying a pension will typically not incur CGT for the same reasons outlined above.

All of a deceased’s benefits have to be paid out as either a lump sum or pension including their account balance. That is, their account balance can’t be transferred to the surviving beneficiary’s account in the super fund.

If, at the time of death, the deceased wasn’t receiving a pension, then any assets that have to be sold to pay a lump sum will be subject to CGT.

Finally please note there is a different tax table for non-dependants. Spouses are always considered to be dependants of each other.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.